Fundamental analysis is the term used in the context of stock markets; the basis of fundamental analysis is that stocks have intrinsic value due to various factors like the company’s financial performance, industry demand, government policies, global demand, and so on and if one is able to calculate the intrinsic value of a stock than depending on the market price of stock one can buy an undervalued stock that is when the market price is lower than intrinsic value or sell overvalued stock that is when the market price is greater than intrinsic value. In order to understand more about this concept, one should look at some of the advantages and disadvantages of fundamental analysis-
Advantages of Fundamental Analysis
Identification of Good Stocks
The biggest advantage of fundamental analysis is that it helps you in learning about the various complexities of the stock market and thus helps an investor to identify goods stock having good business model and future while avoiding bad stocks. In simple words just like a good soldier knows about the landmines and avoids putting his foot on the landmine in the same way a good investor through fundamental analysis can avoid the landmines of stock markets which are nothing but fundamentally poor stocks.
Solid Base for Investment
Stock markets are like a tunnel and if you do not have any knowledge about fundamental analysis or technical analysis then you can be lost in that tunnel and fundamental analysis is like a torch that helps you in getting through the tunnel of the stock market with flying colors. In simple words when you are spoilt for choice and have plenty of stocks to buy then fundamental analysis can be of great help in the identification of choosing the best stock out of many good stocks.
Helpful During Panic
In case of panic when everyone is selling stocks an investor who has done a fundamental analysis of his or her portfolio holdings will never panic because in case of panic every stock falls whether it’s good or bad but in the case of fundamentally strong stocks they recover quickly whenever stock markets recover. In simple words when you have an umbrella with you then you will not worry about heavy rains as an umbrella will save you from heavy rains in the same way fundamental analysis is that umbrella which saves you from bad weather which keeps happening during the panic in stock markets.
Disadvantages of Fundamental Analysis
No Guarantee of Profit
The biggest disadvantage of fundamental analysis is that there is no sure shot guarantee that if an investor has identified an undervalued stock that he or she will make a profit because there are many examples where an undervalued stock keeps performing poorly for a very long period of time and besides not all information is available in the public domain which results in the fundamental analysis being incomplete and thus inaccurate.
Time Consuming
Fundamental analysis is not a walk in the park as it involves considerable effort and time on the part of the person doing the analysis and hence it is a tradeoff between time spent on doing fundamental analysis and profit due to fundamental analysis which for many is not feasible option and hence people tend to avoid getting too much into the fundamental analysis.
Long Time Frame
In the case of fundamental analysis if one is able to identify an undervalued stock and purchase that stock in the hope that it will rise then it is not a surety that stock will catch up with intrinsic value quickly. In the case of stock markets, there are numerous examples where stocks traded below their intrinsic value for several years and hence if you are putting money into the stock for a very long term that is 10 to 20 years than fundamental analysis can be of good help otherwise chances of you getting frustrated with non-movement of stock price are high.
As one can see from the above that fundamental analysis has pros as well as cons and that is the reason why any investor looking to purchase stocks only on the basis of fundamental analysis should carefully read the above points and then only should take any decision regarding investment only on the basis of fundamental analysis.